China will need to bank on coal-to-olefins projects to meet olefin
demand over the next five years, HSBC's global research team said in a report
issued Thursday.

"Though the olefins demand outlook in China does not look strong in the
short-term, over a five- year period, refinery-based olefins capacity in
China will not be able to meet the expected rise in demand," Sriharsha Pappu,
the HSBC Middle East North Africa petrochemicals analyst who led the team
that wrote the report, told Platts.

The report titled "How elastic is plastic" follows comments from a
senior official of China's National Petroleum and Chemical Planning
Institute, or NPCPI, who said that by 2015 coal-based methanol-to-olefins
project will become viable even though the technology being used in China is
still experimental and many of the plants are still run on a pilot basis.

A coal-to-olefins project involves the conversion of coal to synthesis
gas. The purified synthesis gas is then converted to methanol, which is in
turn converted to olefins.

While Yi Bai, the vice-president of NPCPI said the expected buoyancy in
crude prices would stimulate coal-to-olefins projects, the HSBC analysts said
the limited growth of refining capacity in China, and in turn, the limited
growth of refinery-based olefins capacity would support such projects.

"Crude oil prices over 2011-2015 will be higher than in the previous
five years," Bai said Thursday at the China Petrochemical Focus 2011
conference being held in Shanghai.

REFINERY-BASED OLEFINS CAPACITY INADEQUATE TO MEET DEMAND

HSBC's Asian oil and gas team expected Chinese refining capacity to grow
by 2.9 million b/d over 2010-15, and this implies an expected increase in
olefins capacity of 3.2 million mt/year.

However, HSBC expected olefins demand to grow by 9.1 million mt/year in
the same period. "It is clear that refinery-based expansions alone will not
be sufficient to serve the market and that alternative routes to adding
capacity are required," the HSBC analysts wrote in the report.

Coal-to-olefins capacity will rise at the rate of 6 million mt/year in
the coming years, the HSBC report said.

While Bai said in Shanghai that in a few years time it would be clear
that it was not mere optimism that led to the construction of these plants,
and that they were using proven technologies, the HSBC analysts said the key
questions surrounding the coal-to-olefins process pertained to process
economics, stability and competitiveness versus the traditional routes of
chemical production.

"The successful startup at the Shenhua Baotou plant in August 2010 has
helped alleviate some concerns regarding the coal-to-chemicals route. While
the Shenhua Baotou methanol-to-olefins plant has faced some initial teething
trouble, the stabilizing of its operations will go a long way in establishing
the viability of the process," the HSBC report said.

WHAT'S HOLDING COAL-TO-OLEFINS PROJECTS BACK?

The HSBC report said that while the fragmented nature of the industry
with small plants, difficulties in accessing coal and access to commercially
viable technologies had emerged as the main roadblocks in coal-to-olefins
projects, China's National Development and Reform Commission, or NDRC, had
recently set standards for minimum plant capacities required to gain approval
for a new projects.

The minimum capacity for a coal-to-olefins plant has been set at 500,000
mt/year olefins capacity, while a 1 million mt/year limit has been set for
coal-to-methanol projects. "This bodes well for the prospects of
coal-to-chemicals, preventing the emergence of subscale players," the HSBC
analysts said in their report.

As for the problems of coal supply, which includes low grade coal and
reserves which are far inland, the HSBC analysts said: "The Chinese
government, in its 12th five-year plan, is further targeting to reduce the
number of coal enterprises from 11,000 in 2010 to 4,000 by 2015. The bulk of
the announced coal-to-olefins projects are from companies that have coal arms
or utilities businesses with coal supply, thus ensuring feedstock supplies
for the project."

According to Platts data, there are at least five major methanol-based
petrochemicals plants online, with 13 plants and expansions being built or in
the preparation phase.